Grantham: Fed Manipulates Stock Market to Boost Economy

The Federal Reserve is rigging the stock market to boost the economy, and the consequences may be dire, says Jeremy Grantham, chairman of Grantham Mayo Van Otterloo.

When it comes to stocks, “What I worry about most is the Fed’s activity,” he tells CNBC.

“QE2 is just the latest demonstration. The Fed has spent most of the last 15-20 years manipulating the stock market whenever they feel the economy needs a bit of a kick.”

The Fed knows its easing will have little direct impact on the economy, Grantham says. “The only weapon they have is the wealth effect,” he argues. “If you can drive the market up 50 percent, people feel richer, they feel more confident.”

Academics estimate that people spend about 3 percent of the total stock market gain. That means last year’s 80 percent gain in the market boosted GDP by about 2 percent, Grantham says.

“That’s a real kicker, though you don’t see it because of the enormous drag of the housing market.”

But, “The problem is they step away as the market gathers steam and resign any responsibility for moderating a bull mark that may get out of control,” Grantham says.

Grantham also explains why the Fed-stimulated boom-bust cycle is coming to an end.

"In 2000 the Fed had a good balance sheet and the government had a good balance sheet. in '08 it was still semi-respectable, and now it's not. It's not very respectable at all," Grantham says. "So what are they going to use as ammunition if they cause another bubble and it breaks in a couple of years? Then we might have some real Japanese experiences."

Pimco CEO Mohamed El-Erian also criticizes QE2, but for different reasons. “QE2 (isn’t) good in getting us out of a world of low growth and stubbornly high unemployment,” he tells The New York Times Video.